A comparison of recently added Medicare programs estimated that stand-alone prescription drug plans (PDPs) are likely to generate more social benefit at a fraction of the cost of HMO subsidies.

The Medicare Modernization Act (MMA; 2003) expanded Medicare by creating PDPs and increasing subsidies to HMOs. General tax revenues finance most of Medicare spending. Therefore, the best criterion for evaluating the Medicare expansion is its improvement to the welfare of Medicare beneficiaries per dollar of additional spending. This report employed conditional and nested logit models to estimate changes in two components of social welfare: social benefit and social cost. The authors discuss relative fixed-costs of entry into new markets for PDPs and HMOs and the behavior of HMOs with respect to elasticity along the demand curve.

Expanding Medicare drug coverage through PDPs is dramatically more efficient, $0.71 per dollar of welfare benefit, than increasing HMO subsidies, $6.57 per dollar.

A model that simulated the effects of multiple HMOs entering one market found a substantial improvement in the cost/benefit ratio of the HMO subsidy, $6.57 to $2.07 per dollar of welfare gain.

This report presents an economic analysis of two programs that expanded prescription drug coverage through Medicare.